What's the big idea?

picture-13Sometimes the messages in my posts can be a little obtuse; and why not? Whoever said that making $7 million in 7 years was going to be straightforward?!

For instance, my recent post about partnerships seemed to be about deciding whether one partner can double the value of your business … if two can triple the value … three quadruple … and so on … because that is the true ‘cost’ of partners.

But, if you go back and read that post carefully you will see that the equation varies remarkably according to who holds The Big Idea: you or your prospective partner?

So, the real point is this; if you want to make your Number – and, if it is one that requires a compound growth rate of 50+% – listen up to what Money Blog has to say:

I appreciate the insight but most people will never have a workable $10M business in 10 years.

Ouch! šŸ™‚

Seriously, Money Blog is right: you are simply wasting your time trying to reach an [insert Very Large Number] by [insert Very Soon Date] by way of a business …

… at least, if you are without the key ingredient: The Big Idea!

You see, you need to be paid off – big time – but people only pay for value.

So, you have to find a way to deliver that value in a way that others – and, believe me, there are plenty of ‘big guys’ out there just waiting to rain on your parade – can’t themselves deliver; because they [the Big Guys] can throw:

1. Money trying to buy a market

2. Resources to try and bludgeon their chosen market into submission

3. And, they have time to wait the market out

But, the one thing that they can’t offer is creativity, because creativity doesn’t come out of a committee or a corporate training manual.

So, the only way for you to take a business to the levels required to generate that kind of ‘new money’ wealth is by applying big spoonfuls of creativity … hence, The Big Idea.

It can be an idea that:

1. Opens up a totally new market – the highest risk / highest return option: for every YouTube there are thousands of wannabes that come and go. Also, opening up new markets is something that usually does require time/money/resources because your market may be slow to catch on to your revolutionary way of doing whatever it is that you want to do.

One of my businesses created a new market for a service that was previously handled either in house by the large corporates or outsourced to other equally large corporates AJC: none of whom appreciated an ‘upstart’ like me trying to elbow his way into their turf]; being the first on the market with my new way of doing things, I had to spend a long time educating my potential clients before they would ‘hop on board’ … of course, once they did, I had little real competition – at least for a couple of years. But, it’s a looooonnnnggggg road …

2. Improves a product or process in an existing market – to me, the lowest risk / highest return option: You simply take something that works and apply a little ‘magic sauce’ to make it better/faster/cheaper. The Japanese are famous (at least in modern folklore) for taking existing ideas and improving them; and, entrepreneurs have a rich field of existing ideas that they can take and improve upon.

My business really plodded along until I finally realized that I could automate a large part of my call center-based processes; this was late 1999 and I discovered the Internet! For a relatively low cost, I hired a couple of programmers (c’mon $200k a year is cheap compared to how much it would cost a large Corporation to change the way that they do anything!) and created the ‘new process’ that eventually saw my profitability sky-rocket, and my client-base along with it.

3. Provides a way to expand quickly into new markets or territories – not a bad way to go, either, but can require the most capital: simply take an existing idea and find a way to expand geographically (I am not talking about expanding into new product lines … that’s something that the ‘big guys’ specialize in). An example might be the hairdresser who decides to franchise their unique way of doing business. But, it costs a ton of money to make your business ‘franchise ready’ then for marketing to find potential franchisees.

I used my IT-based ‘competitive advantage’ to take my business from Australia, first New Zealand (a smaller market, to test that I could ‘roll out’ the concept elsewhere) and then to the USA; I used a Joint Venture model – I guess it’s like a partnership, [AJC: I broke my own rule here šŸ˜‰ ] to give me relatively easy access to these new territories … it was a situation where the value of the partner was way more than 50%: their existing infrastructure and client base to ‘incubate’ my new business provided the far lowest cost (and, quickest) way for me to expand into global markets. My plan was to continue growing internationally through the JV model had my business not been bought out …

… and, this is where the Deep Pocketed Big Corporate steps in: to buy your creativity … but, only once your hard work has proved its worth.

So, I applied The Big Idea in many different ways to help grow my businesses shoot me way past My Number.

Oh, and Money Blog, you still may be right; even with The Big Idea very few startups reach the $10 million 10 year sales price mark … but, a GREAT business generates plenty of cash along the way … cash that you should INVEST instead of spend …

that’s how I made $7 million in 7 years!

Oh, and selling my businesses scooted me way past my Number … whoo hoo! I love it when that happens šŸ™‚

How the (not quite as) poor (as other) people make budgets …

OK, there’s no doubt about it: the financially dead do NOT keep budgets and do NOT control their spending, so you are definitely better off by following the Three Step Plan to budgeting simply explained in this video:

1. Have a Goal

2. Make a Plan (i.e. your budget)

3. Keep Track of every dime that you spend.

Simple!

Except, that it won’t make you rich

… because you can’t save your way to wealth.

So, here is the Patented 7million7year 3 Step Plan To Budgeting Your Way To Wealth:

1. Work out what wealth means to you: i.e. find Your Number and Your Date

2. Choose your required Growth Engine

[hint: it will have a lot more to do with increasing income than it does to do with controlling expenses]

3. Do the No Budget Budget … once … that’s it!

Which method do you prefer?

4 more questions to ask when buying a business …

I gave you the 4 absolutely vital questions to ask before buying ANY businessĀ ā€¦, and here are some more, in response to Jeff’s quest to buy a business:

This week I found an air charter business for sale for 825K [AJC: Jeff is a navy pilot]. Ā The sale price includes five airplanes (twin engine pistons) and the FAA certificates required to conduct flight operations for hire. Ā Depending upon the condition of the airplanes, 825K, might just barely exceed the cost of the aircraft, leaving me the profits, employees, and business model for free.
According to the financials listed on the sales ad, the business brings in 600K in revenue and cash flows 216K. Ā That looks like a 36% profit margin to me, which is good from what I can tell. Ā The revenue comes 80% from freight and 20% from passengers. Ā This tells me that the passenger focus I’m interested in is one that they either don’t have much market for, or maybe haven’t tried to exploit.
Needless to say, I’m intrigued. Ā For significantly less than I think I need to start things with my original plans, I could buy an air charter that has airplanes, employees (and pilots), procedures and systems in place AND appears to operate profitably. Ā That would leave me to try and expand the passenger side of the business and as/if it grows, I could slowly begin to acquire the aircraft necessary to take the business to where I want to try and go. Ā All the while having the cushion of a profitable business model to mitigate much of the risk.

I’ve shot an email at the broker asking for more details about the business and the aircraft, but am wondering if you have any bits of wisdom and questions I should consider as I begin looking into the details?

So, the first four questions that I would ask are:

1. Do I understand the business?

2. Am I comfortable with management?

3. What is the business worth?

4. What do I have to pay?

… after those have been answered satisfactorily (i.e. now you are serious about proceeding), it’s time to get ‘down and dirty’ with these additional questions (some of which are specific to this business, but can/should be modified for any other ‘capital intensive’ business):

5. Do I want to own an air charter business?

6. If I did, would this be the TYPE / LOCATION of air charter business that I would want to own (at least, to start out)?

7. If I still did, would these be the type / qty / age / condition of aircraft that I would want (or, at least, could work with)?

8. What is the current value of the aircraft (what it would cost you to buy similar aircraft … NOT the value that they list on their books)?

The answers to these 8 questions will tell Jeff:

(a) if he wants to be in THIS business and,

(b) what he is paying for capital (i.e. aircraft) v goodwill (i.e. past/future profits, etc.)

… obviously, if Jeff could start a new business – from scratch – similar to this and ‘buy’ aircraft and customers, these answers will tell you him much time he can save by buying rather than building.

THEN, he should start looking at profitability, which will barely approximate the numbers that the seller provides to him šŸ˜‰

If Jeff can buy the business for not much more than startup cost (better yet, USED aircraft acquisition cost), as he thinks he may be able to do, then he really only needs to assure himself that the business AT LEAST breaks-even.

Remember, if you undertake a similar analysis for a business that you may be looking at acquiring, when looking at profitability BE SURE TO INCLUDE a reasonable salary for yourself. Many owners ‘bump up’ their profit figures by taking their ‘salary’ out of profits rather than accounting for it as a salary. Is it a family business? They are rife with these kinds of practices …

To protect yourself against this kind of ‘profit inflation’, the question to ask is: “what would I pay for each job that needs to be done” and make sure that you build in the appropriate allowance, whether the current owners do or not.

And, just in case you’re also thinking of buying an air-charter business, here’s the additional questions that Jeff says that he’s started asking:

I’d like more details about the operations…typical freight customers and passengers, typical flight destinations etc…

Plans for future growth?

Condition of the aircraft? Hours, TBO, SMOH.

Expenses…typical employee salaries, pilot salaries, cost per flight hour of the aircraft etc.

Where is the business located?

Is there any real estate included in the sale?

Is the current owner willing to stay on during the transition to help ensure a smooth transfer and train the new owners as necessary?

There you go, a great place to start your questioning process, when looking to buy a business. Now, tell me about your experiences? šŸ™‚

A young man's fancy turns to spring …

Picture 1Just as a young man’s fancy turns to you-know-what when spring is in the air, this not-so-young investor’s fancy turns to real-estate as soon as he arrives back in the home country.

But, I am 5 years out of touch as to values; not to mention, I have grown accustomed to values in ‘per square feet’ and Australia is all metric: ‘per square meter’ rules the day …

… what to do, what to do?

Take a look at the scanned image; it’s really my hand-writing; I submit this near-illegible, piece of potential embarrassment for two reasons:

a) Bad handwriting is a sign of intelligence – ever looked at an old-fashioned, handwritten doctor’s prescription? And,

b) It proves that I really do this stuff that I’m telling you about. It works!

You see, the funny squiggles on the scanned image told me all that I needed to know about commercial real-estate values in the Melbourne inner-city suburb of South Melbourne [AJC: unlike many major US cities, the ‘south side’ of Melbourne is not dangerous … it’s ‘chic’] in less than half an hour, here’s how:

Assessing Rental Values

I visited an on-line commercial real-estate site [AJC: this won’t work for residential; but, it will work for larger multifamily, as well as offices, warehouses, etc.]; in the US I use loopnet.com and in Australia I use sites like realestate.com.au

I then scrolled through listings of my target property types (in this case, offices) in the area of my choice (in this case, South Melbourne) and listed Properties for Rent – two columns:

Column A: size of building (i.e. rentable area);

Column B: annual rent

I then entered the same figures into a spreadsheet and graphed the two columns as a line chart; here’s the actual one that I produced for South Melbourne:

Picture 1

This simple graph shows the size of the properties that I was looking at along the bottom (Column A along the X-axis) and the annual rent being offered up the side (Column B up the Y-axis) … and, it tells me an awful lot:

– The smaller the property, the larger the (relative) rent

– The average rent is $249 and the median is $306 (both easy to calculate using the built-in tools in the spreadsheet)

But, you can really see what is happening on a graph like this – something that you would probably miss entirely if you were just scrolling through listings – there seems to be two separate rental markets: one around the $200 per square meter price point, and another one around $300 psm.

Now, if I was really looking to rent (I’m not; I’m a buyer), and if I was looking to rent a space around the 500 square meter size range, I’d be asking to inspect the three properties around the $200 per square meter price point first, then I’d start working my way up. I might also look at a couple around $300 to see if there is a quality difference … I’m betting ‘no’.

Assessing Purchase Values

Using the same on-line commercial real-estate site, I then scrolled through the ‘for sale’ listings of my target property type and again listed Properties for Sale as two columns:

Column A: size of building (i.e. rentable area);

Column B: sale price

As before. I entered the same figures into a spreadsheet and graphed the two columns as a line chart (again, for South Melbourne):

Picture 2

This graph – similar to the first – shows the size of the properties that I was looking at along the bottom (Column A along the X-axis) and the sale price being asked up the side (Column B up the Y-axis) … even though there’s usually fewer ‘for sale’ than ‘for rent’ listings, it tells me even more:

– The smaller the property, the larger the (relative) sale price

– The average sale price being asked is $4,600 per square meter (sounds like a lot – and, it is … prices are high in Melbourne – but you can just divide by about 11 to see the price per square foot) easy to calculate using the built-in tools in the spreadsheet).

More importantly, at least for the smaller properties on offer, there are two distinct price points: $6,000 psm and $3k – $4k psm … now, you can divide the list into Class A office space and Class B/C if you have enough listings, because that will probably explain such a large difference. And, there’s nothing like a quick ‘drive by’ or two to confirm.

Since I’m looking for 400 square meters, for a co-working project that I am looking at, this is telling me pretty quickly that if i can find a decent office in that size range for $1+ million, I might be onto a bargainĀ  … and, that’s something that I just love šŸ™‚

Oh, by comparing the average rents to the average sale price (and confirming with a few listings where both a rental price and sale price are offered – which happens more often than you may think), I get a quick indication of current cap. rates: around 6.2% in Melbourne … I must have rocks in my head even thinking about investing here!

At the very least, by doing this exercise, I have very quickly and easily laid the groundwork for a sensible discussion with a local Realtor …

BTW: If the properties in your area vary by class (eg Class A, B, C) and by types of leases offered (eg Triple Net for some, but not for others) then you may want to graph these separately … but, start on one graph and see what that shows you.

How do you eat an elephant?

One_PercentWe all know the Richest Man In Babylon and the Automatic Millionaire approach to getting rich (very slowly, and if we ignore inflation … you wish!): simply save 10% to 15% of your gross salary …. and wait.

But, that sage advice is doled out like just something that you can easily do …

… but, there’s a couple of problems:

1. It’s not so easy to save that much if you’ve got a stay-at-home spouse, three hungry kids, a car loan and a mortgage to ‘feed’; I mean, not everybody started reading personal finance blogs in their diapers [AJC: that’s when they start writing them! šŸ˜‰ ], and

2. It’s not enough: inflation, financial crisis, work crisis, home crisis, etc. all ‘eat’ into your savings and decimate your Save 15% Until You Die Or Retire Whichever Is Worse plans.

Fortunately, I have a solution to both problems:

We solve the first problem by remembering that ago old adage / riddle:

elephant_eatingQ: How do you eat an elephant?

A: One bite at a time!

It’s the same with savings: set your target at 15% of your gross salary, then make a start by saving just 1% more than you are saving today. If you’re currently saving nothing, then I guess you’re now saving 1% … infinitely more than before šŸ˜‰

As often as you can, but no less than monthly, increase that savings amount by 1%. Repeat until you reach 15%.

In Australia, we have $1 and $2 coins; I just automatically throw these in the center console of my car. Last time I checked, there was $50 or $60 in there … if I were poor, I guess I would trundle off the the bank and deposit that in savings account, until I had accumulated enough to add to my 401k.

You probably won’t even miss the ‘lost’ spending money …

Then we can solve the second problem by saving even more; here’s how, and you won’t even feel it, I promise:

You only save more when you are allowed to spend more!

It’s a trick that I taught my children: when they get money (any money: an allowance, a gift, find it on the street, etc.) half goes into Spending and the other half into Savings.

So, too, does it go for you: anytime that you get any additional money [insert ‘found money’ methods of choice: a pay increase, a second job, a windfall, loose change that you save out of your pockets, a gift, a manufacturer’s cash rebate, tax refund check, etc., etc.] you Spend half and you Save half.

Over time, you will find that your rate of savings goes up tremendously … and – almost – painlessly (because you get to spend the other half)!

Of course, there is a third solution: simply contrive to earn more money from businesses and/or investments such that your savings won’t make any difference to you …

… but, I encourage you to try my “eat the elephant” Making Money 101 strategies as well because the money that you have saved will help you to fund these venturesĀ  – with enough left over to ensure that you have a safety net of some sort in case your plans don’t work out; and, even if things don’t work out the way you expected, if you followed those basic guidelines, you’ll probably find that you’re still better off than 90% of your neighbors šŸ™‚

What to do when you are upside-down on your mortgage …

upside-down-houseRyan – one of our Millionaires … In Training! – is upside down on his mortgage; if you can’t afford the payments (and, I have some guidelines to help you decide when that point has been reached), then I would generally suggest that no matter whether you are right-side up, upside down, or sideways, that you should get out!

But, Ryan is a high-income earner and high-saver already so he has decided to … well … I’ll let him tell you:

If I could wave a magic wand, I would not be upside-down on my mortgage, but that will correct itself over time as we are not planning on moving soon. While we could short sell the house and rent, we will not likely do that. We are emotionally tied to the house and would not, in my opinion have much upside with a rental because we would have to either float the note on our mortgage or pay the taxes on the difference on a short sale, all to pay MAYBE $1000/month less and not have the mortgage interest to write off come april 15th. An appreciation of our home of around 5%/year, starting in 2010, [should help by] bringing us back to an equity position around 2012.

A home performs two functions: housing and investment.

Like most dual-purpose things, owning your own home is probably a poor compromise on both ā€¦

ā€¦ in my experience, you can usually rent a better house than you can afford to buy AND can usually find much better returning investments.

Yet, I recommend that one does own their own home, for a number of reasons:

1. Often it can turn out to be a personā€™s only investment,

2. It is a ā€™safety netā€™ in case all else goes wrong,

3. You have continuity of tenure (the ā€˜landlordā€™ wonā€™t kick you out, as long as you keep up with the payments)

4. Over time, you may build up equity that you can ā€˜releaseā€™ to kick-start other investing activities.

For me, it was always 3. (and, the associated ā€˜emotional attachmentā€™ that comes with calling your house your ā€˜homeā€™) that held the most sway as I always expected to make my ā€˜fortuneā€™ elsewhere. And, I have never actually used the equity for investing (except for my brief HELOC-fueled stock speculation experiment of 2007/2008).

So, I would suggest that you ask yourself the following TWO questions:

i) Can afford the payments? If so,

ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?

If the answer to both questions is YES, then stay. If the answer is NO, then sell/move ā€¦ be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).

This is a question that we all need to ask ourselves at least once per year (or, whenever the market and/or our financial position changes), as – in effect – we are ā€˜buyingā€™ our house every year (by missing the opportunity of selling and putting the money to work elsewhere).

Given the size of our ‘investment’, we should never take the rent/own – buy/sell decision for granted šŸ™‚

Does technical analysis even work?

Rick is skeptical about the value of technical analysis:

I would be very skeptical that technical analysis works- here is a link discussing the controversy:
http://en.wikipedia.org/wiki/Technical_analysis#Empirical_evidence
Iā€™ve never heard of anyone getting very rich from technical analysis. Plus neither Peter Lynch nor Warren Buffett believes in it.
A web site that tells you when to buy/sell stocks strikes me as too good to be true. Letā€™s say that you had a stock purchasing system that WORKED- would you
A Make it available to the world on a website/write a book and make $1M
B Keep it secret, start your own hedge fund and make $1B.
Iā€™m guessing A wouldnā€™t be too likelyā€¦ Also if you did have a system that really worked then making it widely known will cause the system to be useless. Why? For every transaction there must be a buyer and seller. If many potential sellers see a ā€œbuyā€ signal at the current prince they will demand a higher price to sell driving the price up. Similarly, if many potential buyers see a ā€œsellā€ signal at the current prince they will demand a lower price to buy forcing the price down. The final result is that the pool of believers in the system will force the actual price to agree with the systemā€™s prediction of a fair price.

Rick might be a little surprised to know – given my recent posts, apparently condoning technical analysis a lĆ” Phil Town – that I tend to agree with him!

Firstly, keep in mind that I am on record as stating that I am not the ‘go to’ guy on any specific form of investment (perhaps some on business, less on real-estate, even less on stocks, and so on) … my ‘expertise’ (more like ‘passion’) is in the overall strategy of wealth-building, and showing how these individual pieces fall into place.

Also, I am a ‘value guy’ … I love to sniff out a bargain – be it a business, property, or stock – and pounce, and am a fan of Phil Town’s valuation methods (although, I will point out my ‘issues’ with his methodology in a future post).

And, I agree in principle that if you COULD:

a) Identify a stock that was under-priced, and

b) Avoid the market dips by selling out (then rebuying)

… you would increase your returns and – MUCH more importantly – avoid holding onto an under-priced ENRON … one that you thought was cheap but some disaster strikes that the ‘big Boys’ get wind of early.

In principle, that is šŸ˜‰

Look:

1. There have been successful traders, but none that I know of with longevity; it’s a speculation / business … so, if you are prepared to take the chance on the big run up – then sell off – PERHAPS, just perhaps, you can make it big? Jesse Livermore did it 4 times (before putting a gun to his own head when he crashed for the 4th time).

2. Phil Town suggests that the ‘big guys’ (the huge mutual funds) put so much money in/out of the market that they have to make their move over a number of weeks to avoid the sudden price movement that you suggest. IF this is true and IF you can use technical signals to tell you when the run up/down is occurring, then Phil says that the smaller investor can use these signals to move instantly (in 8 seconds, v the ‘big guys’ 6 weeks).

… and, I have certainly used Phil’s methods to suffer ‘only’ a 15% loss when the rest of the market soured by 50+% (and, you need to remember that I have been actively trading since the crash UNTIL it bottomed and have been in cash since for reasons unrelated to the market), so my personal experience is that the ‘3 indicators’ ARE useful.

The catch is, I don’t know why, because they are all PRICE indicators, not VOLUME … in fact, volume only tells you of an increase in activity, there can be no net buying/selling because there are two parties in every trade (the ‘hint’, I guess, is in the price … it goes up/down according to market sentiment).

So, I am a fan of ‘value investing’ (if you can find the right way to reliably value a stock and can then find one that is way under priced … I believe that this happens often enough to make it useful) and am experimenting with the technical indicators to get in/out, but am – like you – skeptical, but not complaining while I am getting positive results …

… but, please DON’T read this post, I am planning to start my own hedge fund šŸ˜‰

This week’s Carnival of Personal Finance is out; we’re buried in their list somewhere ….

To MLM or not to MLM? That is the question …

Robert Kiyosaki (of Rich Dad, Poor Dad fame) is fabled to have ridden to success on the coat-tails of the ‘network marketing’ (a.k.a. MLM) community, who are said to have distributed his books to ‘downlines’ by the millions … or, so the story goes.

But, it is true that RK is a fan of MLM, as this video proves; the (justifiable, in my opinion) reasons that he gives is for the business education that it gives you …

… and, I agree. My only issue with MLM is that you are putting your future in the hands of the MLM company: you build a huge profitable business generating millions of dollars a year in passive income (as my wife’s old school chum does!), but what happens if they change the rules or, worse, close their doors or shut down the MLM distribution arm of their business?

But, I do think that if you simply substitute the words: “part time business” – better yet, “part time online business” into Robert Kiyosaki’s video, then you will have all of the benefits of MLM in a much more ‘new millennium’ platform.

It could be:

1. An information products site,

2. A web 2.0 (i.e. the “next FaceBook”) business,

3. An eBay business,

4. ??????

Of course, there are still risks: for example, you could build a massive e-Bay business and have your account suspended on a ‘technicality’ (as happened to my son a few months ago); risks abound but if you start small, cheap and see what develops, you will at least gain the #1 objective that TK mentions: a business education šŸ™‚

The mythical stock market guarantee …

In a recent post I spoke about various products that purport to ‘guarantee’ your returns in the stock market … in the current environment, it’s totally understandable that investors would be looking for such guarantees. But, you pay for them …

… instead, I suggested:

You can provide yourself a similar – or better – result at far less cost: buy a low-cost Index Fund and wait 30 years to cash it out; I can virtually ā€˜guaranteeā€˜ an 8.5% minimum return :)

Rufus, though, took me to task, citing the Japanese stock market:

Hereā€™s a prediction for youā€¦.In about 5 years the NIKKEI index will show you to be completely full of it even at your 30 year timeframe. If you had picked up the NIKKEI 225 in 1990 youā€™d now be down 75% just on your principal. Fun! If you had picked it up in 1985, youā€™d be about even today, which is still an absolutely massive loss against inflation. Your entire premise has a market survivor bias built into it to which you are blind. There simply are no guarantees.

Firstly, Rufus is right … there are NO GUARANTEES in life .. especially when it comes to the stock market.

BUT, what I offered was a ‘virtual guarantee’:

It is simply based upon the fact that the past 75 years of the Dow Jones have seen NO 30 year periods (including buying in the day before the biggest stock market crash in history) of returns less than 8.5%.

Iā€™m not sure whether Japan could claim anything remotely approaching the same track record, nor are/were its fundamentals the same as the USA.

From a practical standpoint, I can only tell you this:

1. I invest using history as a guide to setting my benchmarks, but I always buy on value: i.e. do the stocks, RE, businesses look cheap at the moment, and

2. I invest in markets where, if things turn drastically sour, then everybody else is likely to be in the same boat … and, by everybody, that means the whole world.

If I’m going to be peeling potatoes, then so is everybody else … hence my major stock market investments are always in the USA.

Rufus, of course, ONE DAY, there will be a 30 year period where this does not hold true for the USA either, but by then Iā€™ll be learning to speak Mandarin Chinese ;)

Bunker Strategy For Surviving A 12 to 24 Month Recession

Nobody_Knows_YouThe blogoshpere is alive with posts that trumpet that Suze Orman has changed her financial advice .. some of it inspired by this excellent article from Yahoo Finance News:

Personal finance gurus usually treat credit card debt as the plague and urge consumers to pay it off–ASAP. But this week, Queen of Personal Finance Suze Orman announced on The Oprah Winfrey Show that the old advice is wrong. The recession has made job loss so prevalent, she says, that consumers now need to make creating an emergency fund with eight months worth of expenses their top priority.

Now, I also happened to be watching that Oprah show [AJC: I can blame my wife … she watches religiously … can I help it that I am sometimes also standing withing ‘eye shot’ of the TV šŸ˜‰ ] where Suze said:

If you have an unpaid credit card balance [and] not much saved up in emergency savings, I need you to listen up. My advice has changed. I want you to only pay the minimum due on your credit card balance, and instead, make it your top priority to build as much of an emergency cash fund as you can.

Now, I think that Trent at The Simple Dollar hosted the best discussion on Suze’s comments, and I suggest that read both Trent’s post and all of the comments before you read on; Trent said:

In this environment, making the decision to jump from debt repayment to emergency fund building is about two years overdue.

I propose a different solution.

First of all, ignore a huge, long-term goal like an eight month emergency fund. Instead, if youā€™re worried about the downturn, focus on three key things through the rest of this year (and thus, likely, through the bottom of the downturn):

One, apply some realistic frugality in your life.

Two, acquire no new debt.

Three, build up your emergency fund a little now, but be prepared to reduce it in 2010.

I agree with Trent, asking people to save up to 80% of their salary for the next 12 months is way too much too late šŸ™‚

And, I agree with Trent’s basic ‘bunker mentality’ of tightening the belt, but I am actually going to advocate a totally opposite three-step strategy, and here it is … 7million7years’ Patented Bunker Strategy For Surviving A 12 to 24 Month Recession:

One, ramp up your Making Money 101 strategies …. during recessionary times, double them if you can (i.e. save 20% – 30% of your income; save 100% of any ‘found money’).

Two, acquire some critical new debt.

Three, use that new debt to build up your emergency fund a lot for now, but be prepared to dramatically reduce it when the recession turns.

Question: Who of sound mind acquires new debt in a recession?

Answer: Anybody who wants to survive!

Look, if you didn’t start storing nuts for this recessionary winter in 2005 / 2006 then you probably have NIL chance of building a large enough emergency fund to tide you over if you do lose your job now or soon … worse, if you do lose your job, it could take months to find another one in the current market.

So, what to do?

Simple, look for where you already have nuts stored: for many of you, it will be in your house.

IF you still have equity in your house, simply refinance out as much as you can up to Suze Orman’s 8 months emergency fund limit (however much that may be for you) PLUS a sufficient ‘buffer’ to make 12 – 24 months of mortgage payments. Now may also be a good time to consolidate your credit cards and other higher interest loans into the same loan (not normally a strategy that I would recommend … but, this is an unusual plan that we are executing) …

… and, fix the interest rate (so long as the loan conditions allow you to pay off as much extra as you like when you like!).

Why?

Well, you now have peace of mind … for only the price of 12 to 24 month’s interest on your mortgage, perhaps a very small price to pay for surviving the deepest recession that you will likely see in your lifetime.

If you don’t lose your job, you can pay back the loan whenever you feel that things are somewhat coming back to normal (i.e. jobless rates are dropping again), and if you do lose your job, you have the cash buffer to help you survive.

Sure, this is a drastic strategy, which will cost you some unecessary interest and lost investing opportunity as you borrow money at 6+% just to have it sitting in the bank at 1.9% if you are lucky, so I am aiming this strategy only at those who:

1. Believe Suze Orman, but have no hope of meeting her criteria at this late stage, or

2. Believe that their job is at reasonable risk.

For a person on a gross income of $50,000 a year, with a current mortgage of $250,000 (a lot of house!), this rather unique ‘insurance policy’ would cost you less than $100 a week … a lot of money, sure, but small change if it helps you survive the Second Great Depression (well, at leastĀ  the worst recession since the Great Depression).

If so, this is counter-intuitively probably your best chance of protecting your home and family and riding the storm … but, if you don’t get a new job within a few months then you are probably slightly closer to foreclosure.

Or, are you?

You have 12 to 24 months protection (by way of the 8 months living expenses plus interest payments buffer), whereas without doing this you have whatever you can scrape up. Compare that with the alternative: what would you do if you lost your job next month and you didn’t put this plan in place? How could/would you survive?

Your honest answer dictates whether this admittedly ‘unusual plan’ is for you …

… if it is; if you do have the spare equity; and, if you do meet the two criteria listed above, now is the time to execute this plan. If you wait:

a. You won’t be able to refi if you have lost your job, and

b. A HELOC won’t save you, as the bank will probably pull it.

So, refinance your home now and put the spare cash into another bank instead!

Of course, if you don’t have the ‘spare equity’ in your house … cross your fingers šŸ™‚